Global cash flow analysis: How to maximize the value
With the number of small business loans nationwide, the need for better analysis of the potential borrowers’ financial situation is more urgent than ever before. Banks that don’t apply stringent credit analysis processes to smaller loans risk hurting the profitability of the loans. This, in turn, could threaten the overall health and viability of the institution when the volume of those smaller loans inflates the risk of the segment.
Following the 2008 economic crisis, banks faced greater restrictions and costs associated with lending, and ultimately reduced the number of loans issued to small businesses. However, big banks rebounded, taking share of small business lending from community banks. To regain the small business lending market, smaller banks and credit unions are looking for ways to overcome a variety of challenges to regain their share by becoming more efficient and more accurate in the lending process.
One of those challenges is making sure the financial institution has a holistic view of the business applicant’s entire cash flow situation in order to prevent the bank or credit union from writing a bad loan. Having a complete financial picture also helps ensure pricing and terms take into account all necessary information. Sageworks credit and risk solutions consultant Mike McCaffery will discuss the benefits of lenders utilizing global cash flow analysis to reduce borrower risk during an upcoming webinar, “Time Well Spent: Maximizing Value of Global Cash Flow.”
Global cash flow analysis starts with the numbers
A complete financial picture, of course, starts with comprehensive financial data on the business, its owners and any real estate connected to the business or its owners.
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Bankers can have a difficult time getting tax returns and reliable financial statements from borrowers even when the relationship may seem simple, such as a single business owned by one person — maybe with a piece of property or two in the mix. However, anything more complex and the data collection can quickly become convoluted. Data entry gets more drawn out as tracking and accounting for income and debts becomes more complex and time consuming. Automated lending solutions, such as an online loan application, the Electronic Tax Return Reader and a workflow solution, can help with these challenges. These provide channels for applicants to upload loan financial documents online; they simplify tracking of needed documents; and they eliminate data entry.
Global cash flow analysis requires precautions
During the credit analysis, however, the analyst must still ensure that the institution has taken all of this information into account when assessing the applicant’s creditworthiness. A global cash flow analysis takes into account the shared assets, relationships and commingled debts and incomes of the various parties. For example, the borrower may have several properties or business investments that provide cash flow on a regular basis, which is encouraging to the institution to know that there is cash flow to support the additional debt. Global cash flow ultimately allows for a more accurate and helpful analysis on the borrower’s true cash flow situation.
It is crucial that one takes the appropriate amount of time and precautions when conducting a global cash flow analysis. Some best practices to follow include:
- When assessing the cash flows, it’s important to combine the business and personal cash flow but make certain to avoid double-counting cash flow that comes from the commingling of the two entities.
- Look for commingled business and personal debt, as well.
- For loans that are classified as “interest only,” the debt service should be calculated using imputed amortization.
- Obtain updated rent rolls (listing when each tenant lease expires) for each commercial real estate property rather than relying on historical rent rolls. This will provide greater income clarity.
- For lines of credit, assume that they are fully drawn by the business or owner.
- Assume that more than the minimum payment is being made on credit cards.
- Deduct a living expense percentage of the individual’s salary (15-20 percent is a common guideline).
- Use K-1s instead of investment income reported on the 1040 E Part II for an accurate assessment of personal cash flow.
Calculating a true global cash flow is invaluable to successful lending, especially on SBA loans when the difference between a profitable loan and an unprofitable one can be razor thin. Why only look at a fraction of your customers’ financial situation? The extra time and effort during the analysis to calculate the global cash flow is well worth it.
To learn more about the importance of global cash flow analysis and how to simply the process, join the webinar, “Time Well Spent: Maximizing Value of Global Cash Flow.